Buying a home is a major responsibility. If you’re unable to continue paying the mortgage on your house, what happens next? You’ve heard of foreclosure, which can result in losing your home and be financially damaging. But there’s another option called a deed in lieu of foreclosure, which may be less stressful than foreclosure, could have less negative impact on a credit report, and might be faster to complete.
Note: SoFi does not offer a Deed in Lieu at this time.
Here’s what you need to know about a deed in lieu of foreclosure, and when it might be an option to consider.
Key Points
• A deed in lieu of foreclosure involves transferring the property deed to the lender to avoid formal foreclosure.
• This agreement helps both parties avoid the potentially lengthy and costly foreclosure process.
• A deed in lieu of foreclosure provides more privacy for the borrower than a public foreclosure.
• A deed in lieu can negatively impact the borrower’s credit score and future mortgage opportunities.
• Borrowers may still owe the difference between the property value and the mortgage debt unless the deed in lieu agreement specifies otherwise.
What Is a Deed in Lieu of Foreclosure?
While a foreclosure may involve the court and a lengthy process, the alternative, a deed in lieu of foreclosure, is fairly simple.
If your lender agrees, you hand over the deed to them and the lender releases the lien on the property. You may be released from any balance you owed on the mortgage (however, there may be exceptions if you owe more than the home is worth).
And while a deed in lieu will appear on your credit report, it doesn’t have as severe an impact as a foreclosure.
The lender might even offer you financial assistance to relocate or let you rent temporarily while you find a new place to live.
Recommended: Tips On Buying a Foreclosed Home
Working With the Lender
Your lender may only consider a deed in lieu of foreclosure in certain situations.
For instance, the lender might require that you first put your home on the market as a short sale or explore a loan modification.
If you’re completely unable to pay, start by contacting your lender and asking if a deed in lieu of foreclosure is an option. If it is, you’ll be given an application and asked for documents proving your inability to pay the mortgage. The documents will show your income and expenses, as well as bank account balances.
This process can take 30 days or more.
If your application is approved, you may want a real estate lawyer to review it to help you understand whether you are fully released from the financial obligations tied to the mortgage. For example, if the lender sells the home for less than the remaining mortgage balance, are you responsible for that deficiency?
Once you are comfortable with the title-transferring agreement, you and the lender will sign it, and it will be notarized and recorded in public records.
At this point, you will be notified how long you have to leave the home.
When to Consider a Deed in Lieu
One instance when a deed in lieu may be a good idea is if you owe more on your home than it is worth, as long as the agreement stipulates that you won’t owe the difference between the value of the home and what you owe.
If you are unable to continue paying your mortgage, it’s important to know that a foreclosure will leave a nasty mark on your credit report for seven years and make it difficult or impossible for you to take out another mortgage for years.
A deed in lieu will appear on your credit report, but it may not have the same lasting effect. Your credit score will drop, but in the long term, it may not affect your ability to take out a loan.
Benefits of a Deed in Lieu
There are advantages for both the borrower and the lender when it comes to a deed in lieu. For both, the big benefit is not having to go through the long and expensive process of foreclosure.
Because a deed in lieu is an agreement between you and the lender and not an order from a court, you may have a little more flexibility in terms of when you vacate the property.
With foreclosure, you are sometimes forced to vacate within days by local law enforcement. With a deed in lieu, you may even be able to work out an arrangement where you rent the property back for a period. The lender gets a little rent money and you have more time to figure out your next move.
In addition, this option is more private than a foreclosure.
From the lender’s perspective, the benefits of a deed in lieu include avoiding litigation and court time.
Drawbacks of a Deed in Lieu
There are disadvantages as well. A deed in lieu will appear on your credit report, even if it’s not as damaging as a foreclosure. Plus, it may still be difficult to get another mortgage in subsequent years. Many lenders won’t issue you a mortgage until at least four years after your deed in lieu, and government-backed programs typically treat it as a foreclosure.
If you owe more than your home is worth, you may still be on the hook for the difference between the appraised property value and what you owe.
You may be denied a deed in lieu if there are other liens or tax judgments on the property, or if the home is in bad condition and requires maintenance to sell.
Recommended: Home Affordability Calculator
Being Smart About Your Mortgage
The best thing to do, if at all possible, is to avoid getting into a situation where you can’t afford to pay your mortgage. If you’re having short-term financial issues, talk to your lender immediately to see if there is the possibility of delaying a few months’ payment or setting up a loan modification so you can work to pay off your outstanding debt.
Typically, the lender will want to help you; it’s easier to work out an agreement now than several months down the road, when you haven’t paid your mortgage at all and are facing foreclosure.
If you do end up in a situation where you are unable to continue paying your mortgage and you aren’t offered options, consider a deed in lieu of foreclosure as a faster and easier solution than a foreclosure.
If you’re just starting to consider buying a home, create a budget and calculate how much in mortgage payments you can afford each month. Don’t forget to calculate insurance and interest as well. Make sure that you won’t be stretched thin financially.
Recommended: Mortgage Calculator
The Takeaway
If you can’t pay your mortgage and you’re unable to get a short sale or loan modification approved, a deed in lieu of foreclosure may be the best option. Rather than go through the foreclosure process, a deed in lieu allows a borrower to sign a property over to the lender. Your credit will take a significant hit, though not as bad as with a foreclosure.
FAQ
Does a deed in lieu of foreclosure affect your credit score?
A deed in lieu of foreclosure will typically have a negative effect on your credit scores, but a foreclosure would affect it even more severely. Your mortgage will be listed as closed and have a balance of zero, but it won’t be shown as paid in full and can remain on your credit report for up to seven years. Your credit score will probably be affected as long as the mortgage remains on your report.
Why do lenders prefer a deed in lieu of foreclosure to a foreclosure?
There are several reasons why a lender may prefer a deed in lieu of foreclosure to a foreclosure. A deed in lieu lets them avoid litigation, which can be lengthy and expensive. Furthermore, in a foreclosure, the property may remain vacant for an extended period and deteriorate, but a lender will want the property in good condition so it will be easier to sell.
Can you buy a house after a deed in lieu of foreclosure?
After a deed in lieu of foreclosure, you may need to wait several years before you can get a mortgage again. Many lenders won’t issue you a mortgage until at least four years after your deed in lieu, and government-backed loan programs generally treat a deed in lieu the same way they would an actual foreclosure, with a waiting period of several years, depending on the loan type.
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